"All Bhutanese nationals residing in Assam should quit immediately," said Arabinda Rajkhowa, chairman of the United Liberation Front of Asom (ULFA), one of three rebel groups the kingdom wants to evict.

"We will ensure that no Bhutanese enter Assam to buy goods and do business here," Rajkhowa said in a statement.

Bhutanese traders expressed fear the threats could be economically devastating for the landlocked kingdom which relies heavily on India to obtain vital supplies such as oil and medicine.

Indian truck drivers have already stopped entering Bhutan over the 262-km border with Assam fearing being caught in the crossfire.

The ULFA, which wants a separate homeland in Assam, has been accused of orchestrating violence against other ethnicities in the past. New Delhi says the militants were behind the killing of 54 Hindi-speaking settlers last month.

The Indian army, which supports the drive against the militants, has reported the deaths of 123 rebels and eight Bhutanese troops or logistical personnel since the kingdom launched the offensive on December 15.

Separately, an army official said two ULFA militants were killed Saturday in the sparsely populated Indian state of Arunachal Pradesh which borders Bhutan, Myanmar and Tibet.

"It appears the ULFA has set up bases inside Arunachal Pradesh with some of the rebels having already fled Bhutan prior to the military crackdown," the official said.

Bhutan has not released casualty figures from the operation. The rebels deny any significant losses.

It is Bhutan's first military operation against a foreign force since 1865, when the kingdom lost part of modern-day Assam to Britain in the five-month Duar War.

King Jigme Singye Wangchuk has personally toured the battlefield after ordering 6,000 troops to flush out the militants, who defied six years of Bhutanese warnings to leave.

The kingdom had long hesitated to make good on its threats of war fearing the militants would retaliate against Bhutanese civilians.